Are you are thinking of investing in real estate? Congratulations! You are on the right path to financial freedom. When done right, real estate investing can be lucrative. However, finding the right investment property can be a daunting task. There are usually numerous potential investment properties in the housing market, each with its own expenses and income to consider. If you decide to analyze each property, it could very well take you several weeks to get through the list. By the time you are done, you will have missed out on many good real estate deals.
Obviously, this option is not going to yield any desirable results. So, how do you get around this? It is quite simple. There are a number of screening tools you can use to make the process of finding an ideal property easier and faster. One of these tools is the 1 percent rule in real estate. In this blog, I’m going to explain what the 1 percent rule in real estate is and why it can be helpful to investors.
What Is the 1 Percent Rule in Real Estate?
Monthly Rent ≥ One Percent of Total Investment
It is important to note that the total price paid for the property includes not only the purchasing price but also the cost of any upfront renovations or repairs.
The purpose of this rule of thumb is to determine if the monthly rent earned from an investment property will surpass its monthly mortgage payment when evaluating potential purchases. At worst, the investor should break even on the property. In other words, the 1% rule quickly measures an investment property’s ability to produce cash flow.
The rule is used by investors to do quick math on rental properties to figure out whether to look further into buying a property. It is used as a guideline to quickly eliminate real estate properties. This is because other property costs such as upkeep, taxes, and insurance are not taken into account in this rule. It is a simple analysis process that only takes a few seconds and will save you a lot of time when you are trying to find an investment property.
For example, according to the 1 percent rule of real estate, a rental property with a total investment of $300,000 should have a rental rate of $3000 or more per month for it to be considered a good investment. If the monthly rent is less than $3000, the $300,000 purchasing price would not meet the 1% rule. Therefore, the investment property wouldn’t warrant further due diligence.
If you purchase a rental property for $200,000 and renovations cost you $100,000, it doesn’t make sense to rent if for $2,000 per month. The monthly rent should be at least $3,000.
If the monthly rent of a rental property is $2,000, you can make a quick calculation to see that you shouldn’t pay any more than $200,000.
Monthly Rent x 100 = Maximum Purchase Price
So, if the property is listed for less than $200,000, you would know it is potentially a good real estate investment and warrants more analysis. On the other hand, if it is listed for a higher price, you don’t have to waste time on it.
The reverse of the 1 percent rule for real estate can also be useful. The rule can provide a baseline for establishing how much to charge for rent on real estate space.
When to Use the 1 Percent Rule in Real Estate
During rental property analysis, the 1% percent rule is not the final word. You should not use it as the only rule to determine if you are going to purchase a property. It is best used as a prescreening tool early in the process to help you save time by narrowing down a long list of potential properties. This criterion helps you to filter properties that can lead to a good investment that you can do more thorough research on.
Drawbacks of the 1 Percent Rule in Real Estate
The one percent rule just uses the gross rental income. However, not all properties that fail to meet the one percent criteria are bad real estate investments. There are many factors that influence the overall rate of return. These factors include property condition, neighborhood quality and amenities, demographic and socioeconomic trends, vacancy rates, etc. Therefore, it can only be used for quick estimations.
Another challenge to the 1 percent rule is that it shouldn’t be used in high-priced markets. It primarily makes sense when evaluating a small residential real estate investment. If you are buying a large multi-unit building or commercial property, your rental income will need to be even more than one percent of the total price.
Mashvisor’s tools are a better alternative to rental property analysis than the 1 percent rule. They will help you by providing an in-depth analysis of every listing in a market. With Mashvisor’s investment property calculator, you will be able to evaluate a property using numbers such as cash flow, cap rate, and cash on cash return. Not all properties that meet the 1% rule will also meet these goals. This way, you can easily narrow down a list of investment properties in minutes. Even then, you can carry out a quick and accurate investment property analysis on the property of your choice. You won’t have to worry about missing any deals or using quick, inaccurate estimations to rule out properties.
The Bottom Line
To ensure a good return on investment, you need to do a thorough analysis before buying a rental property. The 1 percent rule in real estate is just a prescreening tool that can help you filter potential deals in terms of cash flow. It is a simple calculation you can do in your head to figure out if a real estate deal is worth looking into any further. This can help you to avoid common investing pitfalls and make more money. However, the rule does not necessarily show the investment potential of an investment property. For this reason, make sure you always use the proper tools, like the ones provided by Mashvisor, for your investment property analysis.
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